🧾 Capital Market Chronicles – Episode 192: OPTIONS PREMIUM (Part I)
When you buy an option, you’re not just buying a piece of paper — you’re buying potential. The option premium is the amount you pay upfront to the seller (also called the writer) for this right — the right, but not the obligation, to buy or sell an underlying asset at a pre-decided price.
This payment acts like a ticket to a future possibility: if the market moves in your favour, you can exercise the option and profit. If not, your maximum loss is limited to the premium you’ve paid. 🎟️
However, unlike a movie ticket, this price isn’t fixed. The premium keeps changing — swaying with moneyness, time left until expiry, and market volatility.
🏦 Key Aspects of Option Premium
💵 Upfront Payment
The option premium is paid in advance by the buyer to the seller. This upfront payment gives the buyer flexibility — the right to act only if the trade becomes profitable. The seller, on the other hand, pockets the premium as compensation for taking on potential risk.
⚖️ Impact of Moneyness on Premium
The “moneyness” of an option — whether it’s In-the-Money (ITM), Out-of-the-Money (OTM), or At-the-Money (ATM) — has a direct say in how fat or thin that premium will be.
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In-the-Money (ITM) Options:
Have a higher premium because they already carry intrinsic value and a higher probability of profitable exercise.
(Think of it as buying a ticket to a concert that’s already half sold out — it costs more!) -
Out-of-the-Money (OTM) Options:
Have a lower premium since they currently hold no intrinsic value — profitability depends entirely on future market moves. -
At-the-Money (ATM) Options:
Sit right on the fence, with a moderate premium, balancing both risk and potential.
📈 How Premiums Change with Moneyness
As an option moves deeper ITM, its premium naturally increases, reflecting higher profit potential.
Conversely, as it drifts further OTM, the premium drops, since the likelihood of the option ending profitably decreases.
It’s a live reflection of market expectations — like a mood swing chart of trader optimism!
🧮 Market Assessment: Reading Between the Lines
The option premium is more than just a number — it’s the market’s collective verdict on potential.
It factors in:
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The current price of the underlying stock,
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The volatility of that stock (how jumpy it’s been), and
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The time left before the option expires.
Together, these shape the perceived risk and reward — and therefore, the premium’s price tag.
💼 Premium vs. Brokerage – Not the Same Thing!
It’s easy to confuse the two, but here’s the difference:
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Option Premium: Paid by the buyer to the seller — the true cost of acquiring the right to trade later.
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Brokerage Fees: Paid separately to the broker — just for facilitating the transaction.
In short, the premium belongs to the market deal, while brokerage belongs to your broker’s pocket! 💸
⚡ In a Nutshell
The option premium isn’t random; it’s a reflection of market expectations, time decay, volatility, and moneyness.
It represents risk, opportunity, and timing — all rolled into one small but powerful price tag.
Understanding it is your first step toward becoming an options trader who pays smartly and profits wisely. 💪
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